The Justice Department’s settlement with American Airlines and US Airways on their merger lawsuit involves divestiture of slots at many key airports including the Washington Reagan and New York LaGuardia.

The department intends low cost carriers to get a significant share of these divested slots in an attempt to maintain pressure on passenger fares.

JetBlue and Southwest being the largest low cost carriers possessing the necessary financial strength to acquire these slots stand to gain significantly as a result of this development.

Acquisition of these highly sought after slots will allow these low cost carriers to expand their services and aid growth in their passenger traffic and profits.

The Department of Justice (DoJ) recently reached a settlement on its lawsuit brought against the merger of American Airlines and US Airways (NYSE:LCC). In our view, in addition to these two airlines, this development will benefit the entire U.S. airline industry as consolidation will likely further improve the industry’s financial health through lower competition and higher fares on many routes. JetBlue (NASDAQ:JBLU) and Southwest(NYSE:LUV), in particular, stand to gain from the settlement terms. JetBlue’s stock rose by more than 15% over the two days following the settlement announcement. We have raised our price estimate for JetBlue’s stock by approximately the same extent to $8.45 per share, following this development.

How Does JetBlue Gain From The DoJ’s Settlement With US Airways-American Airlines?

As part of the settlement concessions, US Airways and American Airlines will have to give up slots and landing gates across seven airports in as many U.S. cities. Further, the department intends low cost carriers like JetBlue and Southwest to acquire a large number of these slots in an attempt to bring down passenger fares on routes connecting these airports. Under the settlement terms, US Airways and American Airlines will have to give up 52 slot pairs (take-off and landing windows) at Washington Reagan National Airport and 17 slot pairs at New York LaGuardia Airport. [1] The airlines will also have to give up two gates at each of Boston Logan, Chicago O’Hare, Los Angeles LAX, Miami and Dallas Love Field airports.

These seven cities – New York, Washington, Boston, Chicago, Los Angeles, Miami and Dallas – are among the largest business centers in the country. However, airlines including low cost carriers find it difficult to enter or expand at these airports due to slot and gate constraints. The slot/gate divestiture resulting from the settlement between the DoJ and American-US Airways will remove this restraint for low cost carriers.

Expressing its intent, JetBlue announced in a statement following the settlement that it is looking forward to participate in the divestiture process, particularly at expanding its services at Washington Reagan and New York LaGuardia. We figure that through these divested slots, JetBlue will be able to launch additional flights from Washington and New York on high traffic routes to Florida, Chicago and Dallas. A subsequent increase in the carrier’s flying capacity from this expansion will add to its market share gains resulting from its ongoing expansion on routes connecting Boston and Caribbean destinations. This incremental market share gain over the next couple of years has led to a revision of the price estimate for JetBlue.

Southwest, too, in our view, would seek to gain a share of these divested slots, particularly at LaGuardia to build on its presence at the Newark Liberty International Airport.

For the Justice Department, expansion of low cost carriers on these high traffic routes will ensure lower average fares through increased pricing pressure on legacy carriers. In a statement, the Assistant Attorney General Bill Baer highlighted how the entry of Southwest in New York through the acquisition of slots vacated by the United-Continental combination lowered fares. In 2010, Southwest acquired 36 divested slots at Newark Liberty International Airport to start nonstop flights to 6 cities with connections to 60 more destinations. Subsequently, air fares fell by more than 10% on nonstop routes alone. [2]

Delta Also Expresses Interest In Washington Reagan Slots

In a related development, Delta (NYSE:DAL) too jumped in the fray saying that the department should not restrict bidding for the divested slots to low cost carriers. To support its case, the carrier contended that low cost carriers typically do not serve small and mid-sized cities, while the smaller planes in its fleet are better suited to serve such destinations. The carrier also highlighted its operations at New York LaGuardia where more than 50 percent of its destinations are small and mid-sized cities. [3]

For the Justice Department, alongside seeking lower average fares, ensuring the non-disruption of services between small/mid-sized cities and key airports is a major criteria in allowing airline mergers. Though the settlement with American and US Airways has provisions to prevent disruption of service to smaller cities, if the department were to weigh this factor over lower fares, then Delta too could get a share of slots and gates that will be divested by the American-US Airways combination.

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